Working Paper: NBER ID: w27883
Authors: Vincent Glode; Christian Opp
Abstract: We develop a tractable model of strategic debt renegotiation in which businesses are sequentially interconnected through their liabilities. This financing structure, which we refer to as a debt chain, gives rise to externalities as a lender’s willingness to provide concessions to his privately-informed borrower depends on how this lender’s own liabilities are expected to be renegotiated. Our analysis reveals how targeted government subsidies and debt reductions as well as incentives for early renegotiation following large economic shocks such as COVID-19 or a financial crisis can prevent default waves.
Keywords: Debt Chains; Government Subsidies; Debt Renegotiation; Economic Shocks
JEL Codes: G21; G32; G33; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Targeted government subsidies to downstream borrowers (H81) | Elimination of default waves (C69) |
| Targeted government subsidies to downstream borrowers (H81) | Enhanced capacity of borrowers to make payments (G51) |
| Enhanced capacity of borrowers to make payments (G51) | Encouragement for upstream lenders to renegotiate debts to a default-free level (G33) |
| Government interventions that alter bargaining power (L11) | Incentivization of efficient renegotiation among downstream lenders (G21) |
| Mandating debt reductions for upstream lenders (G21) | More favorable environment for downstream agents to negotiate their debts (G33) |
| Facilitating early renegotiation following economic shocks (F41) | More efficient outcomes (D61) |
| Timing of renegotiation relative to arrival of private information (D82) | Efficiency of renegotiation (D61) |